OVER VIEW OF

FINANCIAL
MANAGEMENT
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Meaning and Definition
of Finance

Business Finance defined, as

that administrative area or set of
administrative function in an
organization which relate with the
arrangement of cash and credit so
that the organization may have the
means to carry out its objectives as
satisfactorily as possible

In simple terms finance is defined as

the activity concerned with the
planning, raising, controlling and
administering of the funds used in
the business.
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Financial Management

Financial management is managerial

activity which is concerned with the
planning and controlling of the firms
financial resources.

Howard and Uptron define financial

management as an application of
general managerial principles to the
area of financial decision-making.

Financial management is the

operational activity of a business
that is responsible for obtaining and
effectively utilizing the funds
necessary for efficient business
operations- J.L. Massie.
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Nature of Financial
Management

The nature of financial management

refers to its relationship with related
disciplines like economics and
accounting and other subject
matters.

The area of financial management

has undergone tremendous changes
over time as regards its scope and
functions. The finance function
assumes a lot of significance in the
modern days in view of the
increased size of business operations
and the growing complexities
associated thereto
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Finance and Related
Disciplines

Economics

Accounting

Production

Marketing

Quantitative Methods

Costing

Law

Taxation

Treasury Management

Banking

Insurance

International Finance

Information Technology
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Objective & Scope of Financial
Management
Objective of Financial Management

Scope of Financial Management
Role of Financial Management
Functions
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Objective & Scope of Financial
Management

Objective of Financial
Management

It deals with planning and mobilization of

funds required by the firm

objective of profit maximization

to maximize the wealth of the shareholders

to trade off between risk and return

Scope of Financial Management

Role of Financial Management

Functions
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Objective & Scope of Financial
Management

Objective of Financial
Management

Scope of Financial Management

Estimating the total requirements of funds for a

given period.

Raising funds through various sources,

Investing the funds in both long term as well as

short term capital needs;

Funding day-to-day working capital requirements

of business;

Managing funds and treasury operations;

Ensuring a satisfactory return to all the stake

holders;

Paying interest on borrowings & Repaying lenders

on due dates;

Maximizing the wealth of the shareholders over

the long term.

Awareness to all the latest developments in the

financial markets;

Increasing the firms competitive financial

strength in the market &

Adhering to the requirements of corporate

governance.

Role of Financial Management

Functions
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Objective & Scope of Financial
Management

Objective of Financial
Management

Scope of Financial Management

Role of Financial Management

Liquidity

Forecasting cash flows,

Raising funds

Managing the flow of internal funds,

Profitability

Cost control

Pricing

Forecasting Future Profits

Measuring Cost of Capital

Management

Functions
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Objective & Scope of Financial
Management

Objective of Financial
Management

Scope of Financial Management

Role of Financial Management

Functions

Investment decisions

Capital Budgeting

Working Capital Management

Financing decisions

Cost of Capital

Capital Structure

Decisions Leverages

Dividend decisions

Dividend Policy

Retained - Earnings
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Functional areas of financial
management

Determining the source of Funds

Financial Analysis

Optimum Capital Structure

C V P Analysis

Profit Planning and Control

Fixed Assets Management

Project Planning and evaluation

Capital Budgeting

Working Capital

Dividend Policies

Acquisitions and Mergers

Corporate taxation
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Emerging Role of Finance
Manager
1. Investment Decisions for obtaining
maximum profitability
2. Financing decisions through a
balanced capital structure
3. Dividend decisions, issue of Bonus
Shares and retention of profits
4. Best utilization of fixed assets.
5. Efficient working capital
management
6. Taking the cost of capital, risk,
return and control aspects
7. Tax administration and tax planning.
8. cost-volume-profit analysis (CVP
Analysis).
9. Cost control.
10. Stock Market Analyze the trends in
the stock market and their impact
on the price of Companys share and
share buy-back.
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Sources of Finance
Long Term Source
Equity Share Capital
Preference Share Capital
Debentures
Lease and Hire Purchase
Term Loans
Short Term Source
International Sources
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Sources of Finance

Long Term Source

Short Term Source

Trade Credit

Accrued Expenses

Commercial Papers

Short-term Unsecured Debentures

Bank Credit

Overdraft

Cash Credit

Bills Purchased and Bills Discounting

Letter of Credit

Working Capital Term Loan

Funded Interest Term Loan

International Sources
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Sources of Finance
Long Term Source
Short Term Source
International Sources
Depository Receipts (DR)
Foreign Currency Convertible Bonds
(FCCBs)
External Commercial Borrowings (ECB)
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Concept of time value of
money
The price of 10 grams of gold in 1970
was Rs. 430. The price of the same is
Rs. 9000 in 2006. If we deposit Rs.
1000 in a savings bank account, @ 4%
return, we would get Rs. 1020 at the
end of six months.

The relationship of the relative values

of money over a period of time is
known as time value of money. The
value of money over a period is
affected by various factors like
inflation, rate of interest and the
duration or time involved. The concept
of time value is central to understand
financial mathematics and its
applications. The process of computing
time value of money has two
dimensions
1. Computing future values from present values
2. Computing present values from future values
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Compound Interest and future
values

The term compounding implies that

interest payable on a loan or
investment is not paid at the end of
the interest payment term but is
added on to the principal and
interest is calculated on the total
sum in future. This in effect means
that interest is paid on interest.

A= P0 (1+ r)^n
A = the end value after adding the
interest
P0 = the original investment
r = rate of interest per annum
n= the number of years
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Compound Interest and future
values

Interest compounding at
intervals more than once a year

A= P0 (1+ r/m)^n*m Where

A = the end value after adding the
interest
P0= Principal or original investment at
time
r = Rate of interest in decimals
n = Number of years of investment
m= Number of times interest is paid in
a year.

SHORT CUT

A= P0*(Future value of annuity

at given year at said interest
rate) or (FVA n, r,)
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Compound Interest and future
values

Some points to remember about

compounding interest
calculations

For the same rate of interest,

if more number of times interest is paid during

the year, greater will be the future value at
the end of the given year

Greater the number of years, greater the

difference will be in future values, if computed
using different methods compounding like
yearly and semi annually.

When compounding is continuous the future

value can be computed by A= P0*(Future
value of annuity at given year at said
interest rate) or (FVA n, r,)
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Time Preference for Money
Time preference for money is an
individuals preference for possession of a
given amount of money now, rather than
the same amount at some future time.
Three reasons may be attributed to the
individuals time preference for money:
risk
preference for consumption
investment opportunities
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Required Rate of
Return
The time preference for money is generally
expressed by an interest rate. This rate will be
positive even in the absence of any risk. It may
be therefore called the risk-free rate.
An investor requires compensation for assuming
risk, which is called risk premium.
The investors required rate of return is:
Risk-free rate + Risk premium.
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Time Value Adjustment
Two most common methods of adjusting cash
flows for time value of money:
Compoundingthe process of calculating
future values of cash flows and
Discountingthe process of calculating
present values of cash flows.
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Future Value
Compounding is the process of finding the
future values of cash flows by applying the
concept of compound interest.
Compound interest is the interest that is
received on the original amount (principal)
as well as on any interest earned but not
withdrawn during earlier periods.
Simple interest is the interest that is
calculated only on the original amount
(principal), and thus, no compounding of
interest takes place.
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Future Value
The general form of equation for
calculating the future value of a lump sum
after n periods may, therefore, be written
as follows:
The term (1 + i)n is the compound value
factor (CVF) of a lump sum of Re 1, and it
always has a value greater than 1 for
positive i, indicating that CVF increases as i
and n increase.
= CVF
n n,i
F P
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Example
If you deposited Rs 55,650 in a bank, which
was paying a 15 per cent rate of interest on
a ten-year time deposit, how much would
the deposit grow at the end of ten years?
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Example
If you deposited Rs 55,650 in a bank, which
was paying a 15 per cent rate of interest on
a ten-year time deposit, how much would
the deposit grow at the end of ten years?
We will first find out the compound value
factor at 15 per cent for 10 years which is
4.046. Multiplying 4.046 by Rs 55,650, we
get Rs 225,159.90 as the compound value:
10, 0.12
FV 55,650 CVF 55,650 4.046 Rs 225,159.90
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Future Value of an Annuity
Annuity is a fixed payment (or receipt)
each year for a specified number of years.
If you rent a flat and promise to make a
series of payments over an agreed period,
you have created an annuity.
The term within brackets is the compound
value factor for an annuity of Re 1,
which we shall refer as CVFA.
(1 ) 1
n
n
i
F A
i
1
+

1
]
= CVFA
n n, i
F A
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Example
Suppose that a firm deposits Rs 5,000 at
the end of each year for four years at 6 per
cent rate of interest. How much would this
annuity accumulate at the end of the fourth
year?
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Example
Suppose that a firm deposits Rs 5,000 at
the end of each year for four years at 6 per
cent rate of interest. How much would this
annuity accumulate at the end of the fourth
year? We first find CVFA which is 4.3746. If
we multiply 4.375 by Rs 5,000, we obtain a
compound value of Rs 21,875:
4 4, 0.06
5,000(CVFA ) 5,000 4.3746 Rs 21,873 F
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Sinking Fund
Sinking fund is a fund, which is created
out of fixed payments each period to
accumulate to a future sum after a
specified period. For example, companies
generally create sinking funds to retire
bonds (debentures) on maturity.
The factor used to calculate the annuity for
a given future sum is called the sinking
fund factor (SFF).
=
(1 ) 1
n
n
i
AF
i
1
1
+
]
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Present Value
Present value of a future cash flow (inflow
or outflow) is the amount of current cash
that is of equivalent value to the decision-
maker.
Discounting is the process of determining
present value of a series of future cash
flows.
The interest rate used for discounting cash
flows is also called the discount rate.
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Present Value of a Single Cash
Flow
The following general formula can be employed
to calculate the present value of a lump sum to
be received after some future periods:
The term in parentheses is the discount factor
or present value factor (PVF), and it is always
less than 1.0 for positive i, indicating that a future
amount has a smaller present value.
(1 )
(1 )
n
n
n
n
F
P F i
i

1
+
]
+
,
PVF
n ni
PV F
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Example
Suppose that an investor wants to find out
the present value of Rs 50,000 to be
received after 15 years. Her interest rate is
9 per cent.
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Example
Suppose that an investor wants to find out
the present value of Rs 50,000 to be
received after 15 years. Her interest rate is
9 per cent. First, we will find out the
present value factor, which is 0.275.
Multiplying 0.275 by Rs 50,000, we obtain
Rs 13,750 as the present value:
15, 0.09
PV = 50,000 PVF = 50,000 0.275 = Rs 13,750
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Present Value of an Annuity
The computation of the present value of
an annuity can be written in the following
general form:
The term within parentheses is the
present value factor of an annuity of
Re 1, which we would call PVFA, and it is
a sum of single-payment present value
factors.
( )
1 1
1
n
P A
i
i i
1
1
+
1
]
= PVAF
n, i
P A
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Capital Recovery and Loan
Amortisation
Capital recovery is the annuity of an
investment made today for a specified period
of time at a given rate of interest. Capital
recovery factor helps in the preparation of a
loan amortisation (loan repayment)
schedule.
The reciprocal of the present value annuity
factor is called the capital recovery factor
(CRF).
,
1
=
PVAF
ni
A P
1
1
]
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Present Value of an Uneven
Periodic Sum
Investments made by of a firm do not
frequently yield constant periodic cash
flows (annuity). In most instances the
firm receives a stream of uneven cash
flows. Thus the present value factors
for an annuity cannot be used. The
procedure is to calculate the present
value of each cash flow and aggregate
all present values.
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Present Value of Perpetuity
Perpetuity is an annuity that
occurs indefinitely. Perpetuities are
not very common in financial
decision-making:
Perpetuity
Present value of a perpetuity
Interest rate

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Present Value of Growing
Annuities
The present value of a constantly
growing annuity is given below:
Present value of a constantly
growing perpetuity is given by a
simple formula as follows:
1
= 1
1
n
A g
P
i g i
1
+
_

1

+
,
1
]
=

A
P
i g
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Value of an Annuity Due
Annuity due is a series of fixed
receipts or payments starting at the
beginning of each period for a
specified number of periods.
Future Value of an Annuity Due
Present Value of an Annuity Due
,
= CVFA (1 )
n n i
F A i +
= P VFA (1 + )
n , i
P A i
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Multi-Period
Compounding
If compounding is done more than
once a year, the actual annualised
rate of interest would be higher than
the nominal interest rate and it is
called the effective interest rate.
= EIR 1 1
n m
i
m

1
+
1
]
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